Fitch Assigns Georgian Oil and Gas Corporation JSC 'BB-' Rating

Fitch Ratings-London/Warsaw-27 April 2012: Fitch Ratings has assigned Georgian Oil and Gas Corporation JSC (GOGC) a Long-term foreign and local currency Issuer Default Rating (IDR) of 'BB-'. The Rating Outlook is Stable. A full list of rating actions is at the end of this comment.

The ratings are based upon the linkage of GOGC to Georgia's sovereign rating. GOGC's role as national energy company will remain critical to the Georgian economy given the country's position at a crossroads of supply between the landlocked Caspian basin and western markets. Management links to the government are extremely strong and, despite plans for a minority stake sale in future, majority state ownership is consistent with Georgia's ongoing reform programme. Tangible financial assistance has been advanced by the Georgian state over recent years, and the Georgian government has underlined its commitment to continue supporting the financial health of GOGC in its discussions with Fitch.

Positive features in the company's standalone profile, which Fitch assesses at the 'B+' level, are led by GOGC's dominance of the Georgian gas midstream, and favourable margin structure following contract restructurings. Stable fee income from gas and oil transit operations also provides a floor of predictable and high-margin revenues.

GOGC has a large single-counterparty exposure to a subsidiary of SOCAR ('BBB-'/Stable), as the single-purchaser intermediary of gas supplies to the Georgian downstream gas market. The single-purchaser model does reduce GOGC's leverage in negotiations with SOCAR compared to a more open market structure. However, in addition to providing GOGC with a largely fixed midstream spread of c.USD40/mcm, the current structure also gives SOCAR dominant access to Georgia's gas downstream and its own c.USD30/mcm spread on regulated sales. As such, the concentration of risks on the relationship with SOCAR should be viewed against the background of broader energy policy interdependencies between Azerbaijan and Georgia.

Material concerns on the standalone profile are two-fold: size and planned expansion into hydro-electric power. GOGC has been mandated by the government to expand into the power sector, with a hydro power project (two plants in the Namakhvani power plant (NHPP) cascade) which will dominate capex over the next three years. Expansion into power generation is a departure from current operations. The state's rationale for giving this project mandate to GOGC is, however, plausible and presents fewer risks for GOGC than a number of alternative investment opportunities (e.g. overseas upstream expansion).

The investment for this project, while small in global terms (approximately USD265m) will double GOGC's (largely depreciated) balance sheet. Positively, construction and operational risks are lower than average. Negatively, despite the government's generally transparent and constructive approach to the state-owned sector, asset churn is inherent to the role of a national energy company, and there is potential for NHPP to be separated out from the GOGC grouping at some point post-construction. The Ministry of Finance in Georgia has indicated to Fitch their current view that any transfer of NHPP after completion would reflect the importance to Georgia of maintaining the bankability and financial stability of GOGC.

The main constraint on the standalone profile, however, is size. GOGC is small for the rating category (EBITDA of GEL109m/USD67m in 2011). Size is marginally offset by a lowly levered balance sheet, following a government debt writedown, in turn related to a 2010 restructuring of the midstream market and associated delinquent receivables. Capex on existing assets is minimal, further reduced by obligations upon other pipeline operators/sub-operators to fund routine maintenance expenditure on GOGC-owned pipes.

This profile will nonetheless lever up, under Fitch's forecasts, into the 2.5x-3.0x range on a net debt/EBITDA basis following the expansion into hydro power, peaking in 2014. Delevering can occur relatively rapidly thereafter once hydro power revenues with low marginal costs materialise, although leverage is not currently a major constraint upon either the ratings or the standalone profile.

GOGC's rating alignment to the ratings of the sovereign would be expected to track any upward movement in the sovereign, currently 'BB-'/Stable, within the 'BB' category, though, similar to Georgian Railways LLC ('BB-'/Stable), linkage may weaken if Georgia's sovereign ratings were eventually to move into investment grade in future.

GOGC's ratings would also track any downgrade of the sovereign. With regard to the standalone profile, the current assessment of 'B+' incorporates headroom for leverage of up to 3.5x-4.0x with the proposed business mix. Leverage in excess of this level would trigger a lower standalone assessment, though no impact on GOGC's ratings, unless Fitch judged the deterioration to be linked to or simultaneous with weakening of sovereign support.

The rating actions are as follows:
Long-term foreign and local currency IDR: assigned at 'BB-', Outlook Stable
Short-term foreign and local currency IDR: assigned at 'B'
Senior unsecured debt: assigned at 'BB-'